Tax Bill Lets Family Businesses Focus on Wealth Transfer Headache

After years of whiplash surrounding the estate tax, the tax and spending package signed on July 4 places a permanent 40% ceiling on the federal estate tax. This simple, straightforward inclusion in the bill frees 32 million US family businesses to price and plan for succession for the first time in decades.

In what is being referred to as the Great Wealth Transfer, an estimated $105 trillion is poised to change hands over the next 20 years. With the sunset of the 2017 Tax Cuts & Jobs Act less than six months away, family held businesses may have been envisioning tax scenarios from zero to confiscatory.

But the tax package leaves key tools intact. Valuation discounts and the stepped-up basis—two provisions that have been highly effective in estate planning—survived the negotiations.

The tax landscape remains complex. Twelve states, including New York, Massachusetts, Connecticut, and Illinois, impose their own estate taxes between 12% and 20%. These state-level levies stack on top of the federal estate tax and can dramatically raise the overall transfer tax bill.

Tax rate certainty alone won’t protect family legacies. Sixty-one percent of US family businesses still lack a formal succession plan. This means millions of family businesses are ill-prepared for both the financial and emotional challenges that the Great Wealth Transfer will cause.

Estate taxes aren’t the only financial burden likely to be faced by the succeeding generation.

When a strong-willed matriarch or patriarch dies, it’s not uncommon for previously passive shareholders, who were reluctant to speak up during the wealth creator’s lifetime, to demand to be bought out. Intra-family rivalries that lay dormant during the wealth creator’s life may prompt such demands.

There also could be philosophical differences between younger shareholders, who no longer support the business model of the founding family—think fossil fuels—and the older active members of the family. These younger shareholders often want to be bought out to pursue their own entrepreneurial dreams or philanthropic activities.

Regardless of the motive, demands for buyouts frequently create discord and threaten the fabric of the family business. Despite the certainty provided by the new tax law, numerous financing challenges will complicate the search for liquidity.

Family-held businesses have long been the stepchild of the US banking market. Major commercial banks have favored lending to publicly held companies, which typically have more robust auditing, disclosure and governance systems than family-held businesses.

Further, as a result of the banking crisis of 2023 during which Silicon Valley Bank, Signature Bank, and First Republic Bank failed, community banks and regional banks have curtailed middle-market lending.

Banking regulators also have been scrutinizing the quality of loans provided by these community banks because of the banking crisis. The cost of regulatory compliance has risen to the top concern for community bankers, according to the Conference of State Bank Supervisors.

Borrowing money to pay taxes or buy out minority shareholders doesn’t help a company grow. Consequently, lenders have been and will likely continue to be reluctant to provide such capital.

Against this backdrop, choosing the right financing partner becomes crucial. For decades, many mainstream private equity firms have viewed family-owned businesses as prime candidates for highly leveraged buyouts.

Time and again, headlines recount how once-beloved multigenerational companies are saddled with debt, trimmed to hit short-term performance targets, and ultimately carved up or sold to the next buyer, their legacies painstakingly built over decades erased in the span of a single fiscal year.

Owners should seek partnership capital. And several markers can help identify ideal candidates.

Willingness to invest for the long term. A business that has endured 50 years of adversity deserves investors equally devoted to longevity. Value is created slowly but can be destroyed quickly by excessive leverage. Genuine partners avoid loading stable companies with debt simply to juice returns.

Alignment of mission. Capital providers should share the family’s goals, from employment practices to charitable commitments.

Preview and approve planned strategic steps prior to a transaction closing. The capital provider and the family owner as true partners should identify and approve each of the changes from past business practices that the capital provider anticipates bringing to the company’s culture and business practices before they are implemented.

Stress test covenants. The capital provider and the family owner should agree to a system of stress testing the company’s financial performance at levels below what’s permitted in third-party funding agreements, including bank loans, so corrective action can be taken prior to a covenant default.

Education of the next generation. The capital provider and family owner should agree to creating a formal program to educate the next generation of family members so they can become better stewards of the family business and preserve the legacy that the founding members of the family worked so hard to create.

As families evaluate term sheets, the conversation often turns to control. Understanding the tradeoffs between ownership, governance rights, and liquidity is as important as negotiating price.

Family leaders who now enjoy the clarity delivered by the tax and spending package should use it as a mandate to educate successors, formalize succession plans, and court capital partners who meet their partnership standard. Doing so will help them navigate the Great Wealth Transfer’s inevitable challenges and sustain both the business and the community it supports for generations to come.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Robert F. Mancuso is a former SEC attorney and CEO of Capri Capital Partners.

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